It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!

The Three Key Elements of an Investment Bond

Original post by Lexa W. Lee of Demand Media

A bond is a debt instrument that is designed to raise capital by borrowing the money of investors. Bonds are a type of fixed-income security whose payments are known in advance. There are three key elements of a bond that determine its value and whether it is suitable for you.

Contents

Maturity

The maturity date of a bond is the date on which the issuer will repay your principal. The institution that sells a bond guarantees to repay the principal by a set date. A bond that matures within a shorter time will be less risky than one with a longer maturity date because its price will not fluctuate as much. Bonds that mature more quickly will generally pay a lower interest rate. (reference 2)

Principal

The principal, also known as the par value or face value of a bond, is what a bondholder will be repaid on the maturity date. This amount is different from the price of the bond, which changes during its lifetime, according to Investopedia. It sells at a premium if the price is above the face value; it sells at a discount if the price is below face value. The par value of corporate bonds is usually $1,000, but that of government bonds can be more.

Interest Rate

The bond coupon refers to the amount paid as interest at regular intervals, which is usually every six months. Other possible intervals are monthly, quarterly or annually. A 20 percent coupon on a bond with a par value of $1,000 will pay $200 dollars a year. A fixed-rate bond like this has a rate that remains a fixed percentage of the par value. A floating-rate bond has a rate which changes with a specific index, such as the interest rate on Treasury bills.

Additional Information

Institutions that commonly issue bonds include governments, cities and corporations. They issue bonds when they need money for reasons such as construction projects and capital expenditures. The value of bonds are less volatile that that of stocks. US government bonds are considered the least risky because there is little chance of default. Corporate bonds are riskier, so they typically have a higher interest rate. Issuers with with high ratings such as AAA or AA are considered safe, while those with C ratings are considered very risky.

References

About the Author

Lexa W. Lee, a writer based in New Orleans, has freelanced for more than 20 years. Her clients have included WebMD, EverydayHealth.com, "Self", "Central Nervous System News", "Journal of Naturopathic Medicine" and TennisDiary.com. She was a postdoctoral researcher in immunology and holds a Bachelor of Science in biology from Reed College as well as a naturopathic medical degree from National College of Naturopathic Medicine.